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GammaScalpingandaCrashCourseontheGreeks
ByDanPassarelli | 10/21/1101:28PMEDT
Ihavemanytraderscometomelookingtolearnonespecificoptionstradingstrategy:gammascalping.Alotoftradersarecalledby
thesirensongofacompletelynondirectionaltradeinwhichanymovementineitherdirection,evenbackandforthmovementscan
resultinprofitsevenbigones.It'sinteresting.It'salluring.It'ssexy.
Butgammascalpingasatradingstrategyisnotforeveryone.Infact,ofallthetraderswhohaveaskedmetoteachthemgamma
scalping,I'veturnedmostofthemdown.AsamarketmakerontheflooroftheCBOE,Iwasagammascalpereverydayofmytrading
career.Butfornonprofessionaltraders,onlyandhandfulqualifyforthissortoftrading.Onlytraderswhoareverywellcapitalized,very
knowledgeableandexperienced,andwhohaveretailportfoliomarginingshouldevenconsidergammascalping.
Thoughonlysometradersshouldactuallyengagethemselvesingammascalping,itisessentialtounderstandhowitworks.The
gammascalpingofmarketmakersistheflyrodinthemachinethatpricesvolatility.And,afterall,volatilityisthesourceofedgefor
retailtraders.Therefore,itbehoovestraderstolearnhowitworks.Tounderstandgammascalping,tradersmustunderstandhow
optionstraderstradethegreeks.
TheGreeks:ACrashCourse
Thesocalledoptiongreeksaremetricsthatmeasuretheaffectoftheinfluencesonanoption'svalue,suchastheunderlyingasset
price,timeandvolatility.Eachinfluencehasitsownmetric.Delta
Deltaistherateofchangeofanoption'svaluerelativetoachangeintheunderlyingasset.
Deltaisstatedasapercent,writtenindecimalform.Callshavepositivedeltas,putshavenegativedeltas.Soforexampleifanoption
asadeltaof0.45,itmoves45percentasmuchastheunderlyingstock.Ifthestockrisesbyonedollar,the0.45deltacallrisesby45
cents.
Traderscanthinkofdeltaaseffectivelyhowmanysharesoftheunderlyingtheyhave.Imagineatraderhasacall(representingthe
rightson100shares)thathasa0.45delta.Becauseitmoves45%asmuchastheunderlying,itisasifthetraderowns45sharesof
theunderlyingstock.
Atthemoneyoptionshavedeltascloseto0.50.Thefartheranoptionisinthemoney,thegreateritsdelta,upto1.00.Thefartheran
optionisoutofthemoney,thesmalleritsdelta,downto0.
Gamma
Gammaistherateofchangeofanoption'sdeltarelativetoachangeintheunderlyingasset.
Asdiscussed,themoreinthemoneyanoption,thebiggerthedeltaandthemoreoutofthemoney,thesmallerthedelta.Asthe
underlyingstockpricechanges,optionsareconstantlygettingmoreinoroutofthemoney.Consequently,theirdeltasareinaconstant
stateofchange.Sometimesthischangecanhaveaprofoundeffectonthetrader'sP&(L).Itisveryimportanttounderstandhow
changesindeltawillaffectthetrader'sP&(L).Thus,gammaisimportant.
Gammaisstatedintermsofdeltas.Ifanoptionhasagammaof0.10,theoptionwillgain0.10deltasastheunderlyingstockrises,
andlose0.10deltasastheunderlyingstockfalls.
Longoptions(bothcallsandputs)havepositivegamma.Shortoptionshavenegativegamma.Positivegammahelpstraders.Itleads
tothemmakingmoreontheirwinnersandlosinglessontheirlosersthandeltawouldindicate.Negativegammahurtstraders.
Theta
Thetaistherateofchangeofanoption'svaluerelativetoachangeinthetimetoexpiration.
Astimepasses,optionsgetworthless(allotherpricinginfluencesheldconstant).Thetameasureshowmuchvalueanoptionlosesas
onedaypasses.Thetaismeasuredindollarsandcents.Anoptionthathasathetaof0.04losesfourcentsaseachdaypasses,
attributabletotimedecay.
Longoptionshavenegativetheta,thatis,theyareadverselyaffectedbytimepassing.Shortoptionspositionshavepositivetheta
theybenefitfromtimepassing.
Thetaandgammaareinverselyrelated.Thebenefitthatlongoptionshavebecauseofpositivegammaiscounteredbythedetrimentof
negativetheta.Thepositivethetabenefitofshortoptionpositionsiscounteredbythenegativegammadetriment.
Vega
Vegaistherateofchangeofanoptionsvaluerelativetoachangeinimpliedvolatility.
Impliedvolatilityisthevolatilitycomponentembeddedinanoption'sprice.Thehighertheimpliedvolatilitythehighertheoptionprice
thelowertheimpliedvolatility,thelowertheoptionprice.Impliedvolatilitychanges.Theimpactofthesechangesonthevalueofthe
optionismeasuredbyvega.
Vegaisstatedindollarsandcentsinthesamewayastheta.Ifanoptionhasavegaof0.06,itgainssixcentsforeachonepointrise
inimpliedvolatilityandlosessixcentsforeachonepointfallinimpliedvolatility.
StartingDeltaNeutral
Whentraderssetouttogammascalp,theycreateadeltaneutralposition.Theydosobyplacinganoptiontradeandtheyoffsetthe
deltaoftheoptiontradebysellingstock.
Forexample,imagineatrader,Jill,buys100XYZcallsthateachhavea0.45delta.Thepositiondeltawouldbe45thedeltaofeach
option(0.45)timesthenumberofoptions(100).Basedonthepreviousdiscussionofdelta,thatmeansthecallpositionwouldfunction
asifitwereastockpositionof4,500shares.Thus,Jillcouldoffsetherimmediatedirectionalsensitivitybysellingshort4,500sharesof
XYZstock.
ScalpingGamma
IfXYZrisesorfalls,Jill'sdeltawon'tremainflat.Itwillchangebecauseofgamma.Jillhaslongoptions(calls)soshehaspositive
gamma.Sogammawillbenefitherdeltawillchangeinherfavor.HerdeltawillgetshorterasXYZfallsandlongerasXYZrises.
ThisrecalibratingofdeltaasaresultofgammagivesrisetoanopportunityforJill.She'llhedgeasherdeltachangesresultingin
scalpingthestock.Whenthestockfalls(andherdeltagetsshort)she'llbuystock.ThenwhenXYZrisesandherdeltagetslong,she'll
sellstock.Thesescalpingtransactionsofbuyingstockwhenit'slowandsellingitwhenit'shighcreateacashflow.
TheThetaProblem
Recallthatthetradeoffofpositivegammaisnegativetheta.Jill'spositionlosesvalueintheamountofthetaeachday.Imagineher
thetais0.02percall.Onthe100contracts,herthetawouldbe2.00that's$200ofcashperday.That'srealmoney.Thereforein
orderforJill'sgammascalpingtobeprofitable,sheneedstoscalpmorethan$200adayinordertobreakeven.
VegaandTheta
Thetaisafunctionofimpliedvolatility.Recallthatthehighertheimpliedvolatility,thehigherthevalueoftheoptions.Optionsof
greatervaluemust,logically,havehigherthetas.Thatmeanswhenimpliedvolatilityishigh,gammascalpersmustscalpformoreprofit
tocoverthehighertheta.
HowGammaScalpingFactorsintoVolatilityPricing
Marketmakers(exchangememberswhoprovideliquidity)aremajorplayersinthegammascalpingarena.Astheytaketheotherside
ofpublictrades,theyhedgethedeltasandsubsequentlyscalpgammaoflongoptionpositions.
Whenmarketmakersfindtheycannotcovertheirthetabygammascalpingbecausetheunderlyingstockisnotexperiencingenough
actualpriceoscillation,theyareincentedtotryandselltheiroptionstogetoutofthelosingtrade.Theylowertheirbidsandoffers
sometotryandattractbuyers.Ifthatdoesn'twork,theylowerthemmore.Allthewhile,thislowerstheoptions'impliedvolatility.
Inaway,thegammascalpingofmarketmakerslinkstogetherimpliedandhistoricalvolatility.Ifthestockisn'tmovingenough(i.e.,
historicalvolatilityistoolow)formarketmakerstocovertheta,theylowertheirmarkets(i.e.,theylowerimpliedvolatility).
TakeAways
Atypicalretailtraderwillnevergammascalp(maybesome,perhapstheelite).Butunderstandinghowitfitsintovolatilitypricingis
essentialinunderstandingthemechanicsofvolatility.Traderscanusethisinsighttotradeuseimpliedvolatilitywithforesightand
mastery.Mostimportantly,traderscanuseknowledgeofimpliedvolatilitytogainedgeonoptiontrades.
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